Friday, August 19, 2016

Canadian Pensions Unloading Vancouver RE?

The Ontario Teachers’ Pension Plan is seeking buyers for a minority stake in its $4 billion real-estate portfolio in Vancouver, including office towers and shopping malls, according to people familiar with the matter.

Cadillac Fairview, the real-estate unit of Canada’s third-biggest pension fund, is looking to raise about $2 billion from the sale, according to the people, who asked not to be identified. Cadillac Fairview has hired CBRE Group Inc. and Royal Bank of Canada for the sale, the people said. Spokespeople for Cadillac Fairview, CBRE, and RBC didn’t immediately respond to requests for comment or declined to comment.

Cadillac Fairview is the latest pension group seeking to reduce its holdings in the Vancouver commercial market, where prices have reached record highs amid an influx of foreign cash even as new supply drives up vacancy rates. Ivanhoe Cambridge and the Healthcare of Ontario Pension Plan are seeking about $800 million for their office towers in Burnaby, British Columbia, just outside of Vancouver.

The Cadillac Fairview portfolio, which hasn’t yet started marketing, includes 14 properties in downtown Vancouver and Richmond, with some of Canada’s largest shopping centers, office towers, and historic buildings up for grabs. The assets include a portfolio of waterfront properties including Waterfront Centre, a 21-story tower on the harbor built in 1990; the 238,000-square-foot PricewaterhouseCoopers Place; and The Station, a historic property built in 1912 that serves as North America’s largest transport hub, currently pending approval for an added office tower.

Some of the country’s biggest retail assets are also in the mix, such as the Pacific Centre, a downtown retailer with 1.6 million square feet for which Cadillac Fairview submitted a proposal this year to expand. It’s the third-most profitable shopping mall in Canada, according to brokerage Avison Young, with $1,599 in sales per square foot. The center also contains eight office towers of two million square feet, including 701 West Georgia and the HSBC building.

Asset Gains

The net asset value of Cadillac Fairview’s real estate holdings increased 13 per cent to $24.9 billion in 2015 over the prior year amid high demand for assets in North America, according to the latest financial report from the Toronto-based pension fund. It also lists six of the Vancouver properties as worth at least $150 million.

Demand for Vancouver offices has sent prices of properties to record highs in recent transactions, including Anbang Insurance Group Co.’s purchase of the Bentall Centre. The vacancy rate in the city rose to a 12-year high of 10.4 per cent as of June 30 as tenants absorbed 1 million square feet of new space since the same time last year, according to Avison Young. Buildings downtown, where most of Cadillac Fairview’s properties are located, are faring better, with vacancy tightening to 7.8 per cent from 9.8 per cent at the end of 2015.

Additional space is set to flood the market, with six office towers under construction for delivery as soon as this year totaling about 802,700 square feet, and 10 buildings proposed for the city, including Cadillac Fairview’s Waterfront Tower, according to Avison Young’s mid-year 2016 report. Despite the vacancy, rental rates for the best quality assets in Vancouver are the highest in Canada and some U.S. cities such as Chicago and L.A. at about $30 a square foot, Avison Young said.

The walls of Clarence Debelle’s Vancouver office on Canada’s west coast are lined with gifts from his real estate clients: jade and turtle dragon figurines; bottles of baijiu, a traditional Chinese alcohol; and enough special-edition Veuve Clicquot to fuel several high-end cocktail parties.

They are the product of Vancouver’s decade-long real estate frenzy. The city, with its stunning views of the mountains and yacht-dotted harbor, has long been one of the world’s most expensive places to live but price gains have reached a whole new level of intensity this year. Low interest rates, rising immigration, and a surge of foreign money—particularly from China—have all driven the increases.

Consider the latest milestones:

The cost of a single-family home surged a record 39 percent to C$1.6 million ($1.2 million) in June from a year earlier.

More than 90 percent of those homes are now worth more than C$1 million, up from 65 percent a year earlier, according to city assessment figures.

Vancouver is now outpacing price gains in New York, San Francisco and London over the past decade.

Foreigners pumped C$1 billion into the province’s real estate in a five-week period this summer, or about 8 percent of the province’s sales.

After copious warnings over the last six months, including from the Bank of Canada, that price gains are unsustainable, the provincial government of British Columbia moved last week. Foreign investors will have to pay an additional 15 percent in property-transfer tax as of Aug. 2 and city of Vancouver was given the authority to impose a new tax on empty homes.

As Canada waits to see what effect, if any, the moves may have, here are the stories from the city’s wild ride.

The great CanadianVancouver real estate bubble, eh? Just keep buying Vancouver real estate and wait for all those Chinese billionaires and multimillionaires to buy your house at a hefty premium, especially if it has good Fen Shui.

I've been short Canadian real estate for as long as I can remember, and have been dead wrong. I've also been short Canada for a long time and still think this country is going to experience some major economic upheaval in the next few years.

Since I've openly criticized Paul Singer's views on bonds being "the bigger short", I can't see a major backup in yields as driving a housing crash in Canada or elsewhere. Instead, what worries me a lot more is the bond market's ominous warning on global deflation and how that is going to impact residential and commercial real estate, especially if China experiences a severe economic dislocation.

Now think about it, why are several large Canadian pension funds looking to unload major commercial real estate in Vancouver? Quite simply, the upside is limited and the downside could be huge. That and the fact they're looking to sell for nice gains and diversify their real estate holdings geographically away from Canada (incidentally, geographic diversification is the reason why foreign investors would consider buying Canadian real estate at the top of the market).

Some of Canada's large pensions, like bcIMC, are way too exposed to Canadian real estate. The rationale was that liabilities are in Canadian dollars so why not focus solely on Canadian real estate, but this increased geographic risk. This is why bcIMC is now looking to increase its foreign real estate holdings (read more on this here).

Real estate is a long term investment. Pensions don't buy real estate looking to unload it fast (even opportunistic real estate can take a few years to realize big gains) but rather keep these assets on their books for a long time to collect good yield (rents). Even if prices decline, a pension plan with a long investment horizon can wait out a cycle to see a recovery.

That is all fine and dandy but what if pensions buy at the top of a bubble and then there's a protracted deflationary episode? What then? Vacancy rates will shoot up, prices will plummet and rents will get hit as unemployment soars and businesses go bankrupt. They then can be stuck with commercial real estate that experiences huge depreciation and depending on how bad the economic cycle is, it could take many years or even decades before these real estate assets recover even if money is cheap.

I mention this because a while back, I publicly disagreed with Garth Turner on his well-known Canadian real estate bubble blog, Greater Fool, telling him that he's wrong to believe the Fed will raise rates because of higher inflation and that will be the transmission mechanism which will spell the death knell for Canada's real estate bubble.

Instead, I explained that once global deflation becomes entrenched, companies' earnings will get hit hard, unemployment will soar and many highly indebted Canadian families barely able to make their mortgage payments will be forced to sell their house even if rates stay at historic lows.

Admittedly, this is a disaster scenario, one that I hope doesn't come true. What is more likely to happen is real estate prices will stay flat or marginally decline over the next few years, but that all depends on how bad the next global economic downturn will be. And some parts of Canada, like Vancouver and Toronto, will experience a more pronounced cyclical downturn than others (for obvious reasons).

Those are my thoughts on Canadian pensions unloading commercial real estate in Vancouver. As always, if you have any thoughts, shoot me an email at LKolivakis@gmail.com. And please remember to kindly subscribe or donate to this blog via PayPal at the top right-hand side to show your appreciation for the work that goes into these comments.

A friend of mine who up until recently lived in Vancouver sent me this after I sent him the Zero Hedge comment on Vancouver home prices plunging:

No surprise. Once government decides to get involved in letting the air out of bubble, things tend to spin out of control.

Maybe I was wrong, perhaps 15% is big enough to have the Chinese think twice about Vancouver.

If this is so, Vancouver and all of BC is about to experience a massive recession. Any growth in BC in the last five years came from residential construction. Every other sector (mining, forest products, tech) has done nothing. Tourism is still a bit of a bright star but there is only so much you can do with Whistler and the cruise boats.

Never occurred to me that the Chinese may consider Calgary as a destination.

My friend told me the Chinese might view this new tax as prejudicial and it's clearly impacting the market: "a lot of offers were pulled after the tax went into effect."

Unlike me, he thinks that a macro event in China will only accelerate capital out of that country (says "capital controls in China are a joke") and if the loonie keeps falling, Canada will remain a destination of choice.

He also told me that "commercial real estate isn't very correlated to residential real estate in Vancouver because most Chinese are self-employed and work out of their home doing in import-export trading."

That may be true but it's hard to see how a recession won't impact commercial real estate in Vancouver. Still, foreign investors are looking at diversifying their real estate holdings and they will buy some of the real estate Canadian pensions are unloading in that city.

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